Tag Archives: intrinsic value

Why would anyone attribute value to Bitcoin?

Posted on by
Reply

Oh, Cheez…We’re back to this question, again!

As a Bitcoin columnist, I get asked a lot of questions regarding cryptocurrency and I don’t mind that at all because I enjoy educating people on the topic. Whether it’s recommending people this review if they’re looking for trading help, going over the fundamentals of Bitcoin, or answering why Bitcoin holds any value. And I get this question a lot. Today, an answer was requested at Quora.com, where I am a leading contributor on cryptocurrencies:

“Clearly, some people value Bitcoin. But How can
this be? There is nothing there to give it value!”

Many individuals, like the one who asked this question, suspect that Bitcoin was pulled out of thin air-and that it is not backed by gold, a government, or an authoritative redemption guaranty. After all, it is just open source code. What stops me from creating an ElleryCoin using the same code?!

Let’s start with the short answer:

  • Indeed, it was pulled out thin air
  • It isn’t backed by an asset, government or promise
  • You could easily clone Bitcoin (the entire mining ecosystem) and distribute it yourself. It would be exactly like Bitcoin. Yet, Bitcoin is clearly valued by everyone, and your new coin is unlikely to generate interest or adoption.

A More Complete Answer: What is value?

Bitcoin has more intrinsic value than a government printed paper bill. The value arises from a combiation of fundamental properties:

  • It has a capped supply
  • It is widely recognized, liquid, and resistant to legislation
  • It has attained the robust supply-demand of a growing, 2-sided network.
  • It is open and transparent. This elevates user trust
  • Unlike cash and credit, Bitcoin requires no back-end settlement. That’s because it is not a payment instrument. Rather, it is money itself.
  • Finally, it’s value is likely to be durable, because it is not printed by a country that spends beyond its means and racks up debt. In fact, it can never be inflated.

Downside and Risks

But wait! What about the long transaction delay and high cost? There are sharp disagreements anong miners, users and developers concerning block size, transaction malleability, and replay issues. Aren’t these a deal killers? And what about wild volatility in the exchange rate? Doesn’t this retard adoption as a functional currency?

These are transient issues associated with a new technology. Bitcoin is weathering growth pains that arise from a new and distributed governance technology (democracy can be messy!). But, all of these issues have sound solutions. We have witnessed and tested the solutions with various forked coins. Think of these imrpoved altcoins as beta tests. Even if current problems delay the day when you can spend bitcoin at every retail establishment-it is already sucking liquidity from national currencies and becoming the world’s de facto reserve currency.

Many individuals find all of this hard to accept. That is because we have been conditioned to think that ‘value’ arises from assets with ‘intrinsic’ value, the promise of redemption, or by edict. This is not true. In all things (including gold, a Picasso painting, or your labor), value arises from simple supply and demand.

Some individuals claim that all other factors are secondary. But, even this statement is false. All other factors are irrelevant. They may be related, but they are not the source of value.

I recognize that this answer may seem smug or definitive. So, allow me to suggest related questions with answers that are a bit more interesting, because they are subtle. Unlike the question of value, these two questions are open to analysis and opinion: (1) “Will people continue to value bitcoin in the future?” – And (2) “When will Bitcoin stop swinging wildly in value?” (measured by its exchange rate with other currencies).

This is fun! Let’s explore…

Ellery Davies co-chairs CRYPSA, publishes A Wild Duck and hosts the New York Bitcoin Event. Last month, he kicked off the Cryptocurrency Expo in Dubai. Click Here to inquire about a live presentation or consulting engagement.

Is Bitcoin a store of value?

Posted on by
Reply

Bitcoin has many characteristics of a currency. It is portable, fungible, divisible, resistant to forgery, and it clearly has value. Today, that value came close to $20,000 per coin. Whether it has ‘intrinsic value’ is somewhat of a moot question, because the US dollar hasn’t exhibited this trait since 1972. Today, economists don’t even recognize the intrinsic value of gold—beyond a robust, international, supply-demand network.

Lately, Bitcoin is failing as a viable currency, at least for everyday consumer transactions. The settlement of each transaction is bogged down with long delays and a very high cost. The situation has become critical because of squabbling between miners, users and developers over how to offer speed transactions or lower the cost of settlement. Bitcoin forks and altcoins such as Dash and Bitcoin Cash demonstrate that these technical issues have solutions. Since Bitcoin is adaptable, I believe that these issues are temporary.

But an interesting question is not whether Bitcoin will eventually become a consumer currency. It is whether Bitcoin can distinguish itself as a store of value, rather than just an instrument for payment or debt settlement. After all, a Visa credit card, a traveler’s check and an Amazon gift card can all be used in retail payments, but none of them have value unless backed by someone or something. US Dollars on the other hand are perceived as inherently valuable. They carry the clout and gravitas of institutions and populations, without users questioning from where value arises. (This is changing, but bear with me)…

What about Bitcoin? Does owning some bitcoin represent a store of value? Yes: It absolutely does!

Bitcoin is a rapidly maturing two-sided network. Despite a meteoric rise in exchange value and wild fluctuations during the ride, it is the epitome of a stored value commodity. Regardless of government regulation, adoption as a consumer payment instrument, or the cost and speed of transactions, it has demonstrated stored value ever since May 22 2010, when Laszlo, a Bitcoin code developer, persuaded a restaurant to accept 10,000 BTC for 2 pizzas.

The “currency” accepted by the pizza parlor wasn’t a gift card. It was not backed by a government, a prior deposit, dollars, gold, the promise of redemption, or by threat of force or blackmail. When a large community of individuals value, exchange, and can easily authenticate something that has none of those underpinnings, that thing clearly has stored value.

In this case, value arises from its scarcity and a robust supply-demand-network. Because its value is not tied to a government or to other commodities, its exchange rate with other things will be bumpy, at first. But as it is recognized, traded and adopted as a stored value token, the wild spikes will smooth out.

A tipping point will precipitate rapid adoption when…

  • when some vendors begin to quote prices in Bitcoin (rather than national currency)
  • when some of these vendors retain a fraction of their bitcoin-revenue for future purchases, payments or debt settlements—rather than converting revenue to fiat/national currency with each sale

Bitcoin is clearly a store of value, and it is beginning to displace gold and the US dollar as the recognized reserve currency (it is gradually becoming the new gold standard). But before Bitcoin can serve as a widely adopted everyday currency (i.e. as a payment instrument—with or without the stored value of a currency unto itself), it must first incorporate technical improvements that speed transactions and lower cost.

This is taking longer than many enthusiasts would have liked. But, that’s OK with anyone who keeps their eye on the big picture. Democracy is sometimes very sloppy.

Ellery Davies co-chairs CRYPSA, publishes A Wild Duck and hosts the New York Bitcoin Event. Last month, he kicked off the Cryptocurrency Expo in Dubai. Click Here to inquire about a live presentation or consulting engagement.

Spell it Out: What, exactly, backs Bitcoin?

Posted on by
3

On August 1 2017, the value of a Bitcoin was at $2,750 US dollars. Today, just over one month later, it is poised to leap past $5,000 per unit. With this gain, many people are asking if Bitcoin has any genuine, inherent value. Is it a pyramid scheme? —Or is it simply a house of cards ready to collapse when the wind picks up?

In a past article, I explained that Bitcoin fundamentals ought to place its value in the vicinity of $10,000.* (At the time, it was less than $450, and had even fallen to $220 in the following year).

For many consumers viewing the rising interest in Bitcoin from the stands, there is great mystery surrounding the underlying value. What, if anything, stands behind it? This is a question with a clear and concise answer. In fact, it has a very definitive and believable answer—but it is easiest to understand with just a little bit of historical perspective.

At one time, G7 fiat currencies were backed by a reserve of physical Gold or the pooling or cross-ownership of other currencies that are backed by gold. That ended in 1971 when the Bretton Woods agreement was dissolved by president Richard Nixon in Ithaca NY.

Today, US currency is backed by “The good faith and credit of the American worker” (This is the government explanation of intrinsic value). But in truth its future value is loosely tied to one simple question: Does the typical vendor or consumer (for example, someone accepting a $20 bill in exchange for a movie ticket or 2 large pizzas) expect it to buy these same things in the next few months?

A considerable number of speculative components contribute to the answer. For example:

  • Debt: This is the elephant in the room. A house built on debt cannot thrive forever—without a fresh stream of exports and productivity. These are the measures of a nation’s income and its balance sheet. Here, then is the key question: Is new money being printed without a commensurate added value to GDP? After all, this is how a nation repays its debts.
  • Public Trust: Good faith goes beyond debt. Can consumers and creditors be certain that a change of government won’t cause rampant inflation or a willful failure to retire future debt? Can they be assured that their fellow workers will continue to produce and export manufactured goods in ever increasing quantity?
  • Guns & Tanks: Citizens are compelled by law to pay their taxes in official state currency. Even for those who attempt to fly under the wire or use alternate currencies during the tax year, this ultimately forces fiat currency to be recognized and honored.
  • Geopolitical Stability: The US has been a debtor nation for decades and it has significant political and economic disputes with its largest creditors (China and nations of oil-rich gulf states). What would be the effect of these trade partners (a) moving away from the dollar as their reserve currency, or (b) investing the trillions of dollars they have earned in some other country—or within their own borders?

This list is not exhaustive, but each constituent boils down to two fundamental concepts: Supply-and-demand –and– How long will demand last?

The dollar is an invention of a transient government. Even with a long history of stability and a complex banking framework, it is no more real than Bitcoin. Supply and demand for any commodity is based on popular recognition, anti-counterfeit features, innate desire and public goodwill. The real question is: What contributes to the desire to own or spend Bitcoin?

The answer is that Bitcoin is backed by something far more reliable and trustworthy than the transient whim of elected legislators. It is backed by something that carries more weight than the US government. What could possibly guaranty the value of a Bitcoin? After all, it does not convey ownership in gold, and it has no redemption guarantee. There is no picture of Caesar on the coin. (In fact, there is no coin at all!)…

Answer: Bitcoin is backed by math, a firm cap, a completely transparent set of books, and the critical mass of a two-sided network. Although it can be taxed (like any asset), it can be owned and transferred with impunity and without recourse. These may not seem like critical components of intrinsic value, but they are. In fact, they define intrinsic value in the modern era.

Related:

Ellery Davies co-chairs CRYPSA, produces The Bitcoin Event, edits A Wild Duck
and is keynote at this year’s Digital Currency Summit in Johannesburg.

What gives Bitcoin Value?

Posted on by
5

For most of us, figuring out the value of something that we want, comes from research. If you want a new set of wine glasses, you check the price online. Perhaps you consult a catalog. If the set of 8 stemware goblets that you like are a current model from a major company, there are probably many places to buy them. If there are multiple Ebay sellers and many recently completed sales, then you can establish the value with precision.

I’ve written a lot of Bitcoin articles at A Wild Duck. So, let’s dig a bit deeper this time. Let’s talk about the real Pros and Cons of buying crypto currencies. If you are interested in trading bitcoin, crypto revolt would be the place to do it!

Supply and Demand

In the end, an item’s value is a direct result of supply and demand. It’s no different with a currency. Currently, the number of people hoping to buy Bitcoin on Zipmex would suggest demand is currently very high. Firstly, we need to be clear: Despite a raging debate, Bitcoin is a currency and not just a payment instrument. How can I be certain? Try this mental exercise-

Amazon_Gift_CardWestern Union money orders and Amazon Gift cards are each trusted monetary instruments. They facilitate cash transactions. But are they currencies with inherent value? If so, there would be no need to denominate them in units of fiat currency.

A money order is only worth something before it is redeemed. The gift card is only worth $500 when it is purchased or received as a gift. As the $500 is depleted, it becomes worthless. Eventually, it is just a piece of plastic. But like a dollar bill, a bitcoin can be circulated over and over. You may believe that its value comes from the government, but more realistically, its value arises from brand recognition and from pure supply and demand-not from a trusted redemption authority. Of course, Bitcoin’s intangibility does have its downfalls, especially in the world of crypto casinos. While Bitcoin casinos are fairly popular among many, they are seen as very untrustworthy due to their lack of security. On the other hand, crypto casino alternatives such as FunFair.io offer a more transparent option, and the pro’s and con’s between FunFair and Bitcoin Casinos seem to be relatively clear to see.

Bitcoin isn’t the first ethereal stash of bits with value. But it is more durable than others. The latest Pixar film on DVD or On Demand from your cable service provider has value. But piracy reduces the value dramatically. The supply is no longer scarce (no matter the demand) because of the ease and willingness to replicate digital files in any quantity. A Picasso painting is very rare, but it is so scarce, that we cannot gather enough data points to establish a stable value. Even worse, it’s not portable, divisible or fungible and it is nearly impossible to validate in the hands of the average person.

But, commodities like iPhones, Doritos tortilla chips-or even non-branded things, like Idaho potatoes, have a large and fluid market. These things have very measurable value and we can track the change in value over time.

People like to think that money is different than other commodities. In practice, it differs only by its handling characteristics: Compared to a Bitcoin-08Picaso painting or a new iPhone 6, currency has these properties. It is:

  • portable
  • fungible
  • divisible
  • widely recognized
  • resistant to forgery
  • backed by something tangible

Bitcoin has all of these characteristics. In fact, it surpasses your national currency in every way. But many people are confused about that last niggling detail… Aristotle called it “intrinsic value“. They worry that there is no gold-or at least the promise of a stable government-to establish and stand behind the value of a bitcoin unit (BTC). This concern is understandable, but misguided. It is based on wrong assumptions.

Recall that value arises through supply and demand and not simply because of authority or promises. The real question is “Can we trust that the supply is limited and that the demand is durable?” – Or at a personal level: “Will my coins be recognized, coveted and honored in the future? And will they be easy to buy, sell or exchange”

The Case Against Bitcoin as a Currency

At first glance, Bitcoin enthusiasts and early adopters face a frightening fact: Bitcoin is manufactured out of thin air. It lacks the underpinnings of a traditional currency. Referring to that last item on Arisotle’s list above, Bitcoin seems to fail the test of intrinsic value, because it lacks at least one of these properties that guaranty future redemption:

  • A promise of a trusted authority
  • An edict to remit taxes in Bitcoin
  • A fractional reserve requirement
  • Any claim of pegging it to the value to some essential commodity (intrinsic value)
  • Bitcoin doesn’t even offer a perception of uniqueness. The source code is open for anyone to copy. You could create a competing ‘Bob-coin’ tomorrow.

In the absence of at least one of these things, detractors claim that Bitcoin lacks a foundation-and so it is effectively worthless. But value does not come only from authority. It comes from trust and is governed by supply and demand.

snoop-03

The dollar is backed by trust – Not gold, math, nor even history

In fact, math may be a more trusted ‘authority’ than the directors of your national treasury and reserve board. Supply and demand leads to more tangible value than bankers, especially if the math leads you to believe that the demand will continue to outpace the supply. This is why you are comfortable with a $20 bill in your pocket. You have a pretty good idea, that-next week-it will still buy two movie tickets or two pizzas.

Bitcoin has achieved a “two-sided network effect” (Google the term and the economist “Marshall Van Alstyne”). It has captured the public imagination more than Picasso. It cannot be manufactured. With a reasonable understanding of wallets, it cannot be seized, stolen or lost.

The ability to mine new bitcoins is capped with a total supply of 21 million units, and so there is no opportunity for governments to inflate it through mismanagement of taxation or spending. They cannot even inflate it with good intent (for example, when they need to repair a bridge or provide for the poor). Instead, the ability to pay for these services (and all other government functions) forces them to live within a balanced budget. Spending cannot outpace the revenue generated by taxes and bonds. In a Bitcoin economy, the bonds will more likely be paid back by user fees rather than the future debt of unborn generations.* You get the point: Because governments no longer control the printing press, they cannot make hollow promises and then kick the problem into the next administration. With a limited money supply that everyone recognizes as money, governments are forced to live within their means.

What About Uniqueness?

The last item in the list above decries Bitcoin’s lack of uniqueness. You cannot mint your own bitcoins of course-but you can create an equivalent bitcoin ecosystem yourself. If your name is Bob, you can call it ‘Bobcoin’. Many countries and organizations are already doing this.

A Bobcoin is no different than a US Dollar or your own national currency. A government note is difficult to counterfeit, but so is your own signature when placed on a fancy printed currency (call it a Bob-Buck). The problem is that the dollar is widely recognized, trusted and accepted, but few people other than your kids collect Bob Bucks.

Your own currency faces the challenge of adoption. Whether it’s Bob Bucks (paper) or Bobcoin (cryptocurrency), how will you get the world to covet, mine and trade your new currency? That’s the point of a two-sided network. It becomes increasingly more difficult after one method rises to the top-especially if that method is open, transparent and extensible. Bitcoin is open. It is subject to worldwide scrutiny. But this works both ways. Bitcoin can also add incremental improvements that are part of any pretender to the throne.

Bitcoin is not just a transient coin-du-jour. It evolves and so it will not die.

How Can the Value be Measured?

I get this question a lot, and so I am adding the answer here. There is no need to measure the value of Bitcoin or define debt. Its value floats with supply and demand like a true world currency. Because the supply growth is capped and well understood, it is resistant to manipulation. As time goes by, it becomes far less likely to exhibit wild swings in value.

A few years from now, if Bitcoin spikes or tanks by 10% in a short time, you will be more likely to wonder “What is affecting the dollar?” (or Euro), rather than “What is affecting Bitcoin”. Consumers will budget for the cost of a new car or refrigerator in BTC rather than dollars or Euros. You will even see catalogs that print prices in BTC and honor them for the life of the catalog or online sale. After all, in an international market, it makes sense to quote a price in units with no geopolitical boundaries, just as we quote time in UTC (formerly called GMT).

Are these predictions crazy? They are not even bold. For Wild Ducks, they are rather obvious. If we can be accused of dreaming, it is because we are ahead of the game. Look ahead, yourself. The signs are clear…

If Bitcoin has Value, What is the Value?

As Bitcoin adoption moves past enthusiasts and early adopters, the capped supply of coins (21 million, max) will be spread thinner and thinner. This doesn’t play out like a classic shortage, because unlike a supply squeeze on food or medicine, you can work with a smaller piece of the pie each year. The piece needed to pay for a car or an iPhone simply gets smaller as the unit price floats higher and higher.

Last year, I set up an equation to predict how high Bitcoin will float in 5 or 10 years. It involved a lot of WAGs (wild *ss guesses). Although I am a pundit, I am not a mathematician, and so the attempt was incomplete. No need to rehash that exercise.

Passport-s-TAs Hysteria Withers, Bold Becomes Mundane

Eventually consumers, banks, brokers, and governments will recognize that Bitcoin is a far greater opportunity than it is a threat. It pulls the world together by decoupling currency controls from national agenda, inflation, manipulation and loss (You can back up your Bitcoin. Try doing that with your paper money or a defunct bank).

[Ellery Davies is editor of AWildDuck.com. He is also CEO &
Co-Chair of CRYPSA, a recognized standards organization]

_____________
* This is just one reason why an eventual transition to Bitcoin (as currency, and not just as a payment instrument) is in the national interest. It demonstrates to citizens that monetary policy is backed by more than growing debt, inflation or the promises of transient officials. It returns any government or economic entity to a non-inflationary, limited-supply pie. The pieces of pie can grow in value, but the pie cannot be watered down by printing more ingredients, counterfeit or even by enemy action.

Further Reading

Is Bitcoin subversive?

Posted on by
Reply

The debate on whether Bitcoin presents a credible opportunity to become a world currency has two components…

You could add a dozen other discussion points, such as “Is the math reliable?”, “Will it be outlawed by government X or Y?” or “How can a virtual fiat that lacks intrinsic value ever be a value store?” But for this discussion, we flush out the two remaining questions of viability that keep insiders awake at night:

• Can it be adopted as a transaction medium, like a gift card or credit card?
• Can it be accepted as a value “in and of itself”, based simply on supply & demand?

Most early adopters and even some governments acknowledge that a historic time may be upon us. It certainly appears that the time may be ripe for a gradual shift to secure, electronic currencies, whether by design or by a groundswell of adoption.

LinkedIN icon (3D)-sI am a frequent contributor to a LinkedIN discussion group that is a place of intense debate. Participants are cryptocurrency enthusiasts, and so the debate doesn’t address the viability of Bitcoin as a valid mechanism. We all believe that adoption is likely—at least as a transaction medium. Rather, our debate is focused on adoption mechanisms, geopolitical fallout and intrinsic value. Among issues that we address are:

1. Must a cryptocurrency be tied to a government backed fiat currency? — Or can it float based only on trust, supply & demand, and a supply that is capped but divisible?

Most in our group believe that it can float and be a value store on its own merits.

2. Does a cryptocurrency need a perpetual supply-growth mechanism to be viable? — Or can it serve commerce and act as its own stored value with fixed supply cap?

Bitcoin has a fixed, ultimate supply cap of 21M units. Some analysts and pundits are concerned that the supply cap will cause large scale deflation as it is adopted, even if used for only a fraction of Internet commerce. They believe that the deflationary mechanism is a liability. Most people in this group believe it is an asset—maybe, even, the whole point.

3. Could government regulation and disparate national rules eventually damn the whole virtual currency experiment?

Most people in this group believe that certain grassroots movements cannot be easily squashed. Moreover, even strong supporters of government believe that—in the long term—Bitcoin presents more of an opportunity than a threat. There really is no maxim that says national governments must be in charge of a treasury and tinker with value, growth and incentives through a national currency. Bridges can be built and wealth can be redistributed through tax policy and by other means. In the age of global commerce and the Internet, we are beginning to recognize that the trust upon which a currency relies can be based on something that is less political and more involatile than regional authorities.

4. Some wonder if a currency can survive without an underlying asset like gold, or the requirement that taxes be paid in the new form. But the US dollar is not tied to a specific asset and virtual currencies do not need to be the mechanism/unit for paying taxes. For those using any currency with a supply cap and growing adoption, dollar conversion will always get cheaper and cheaper.

Does Bitcoin facilitate crime?

Bitcoin-08One member of our group points to the black eye that Bitcoin acquires after news events such as the take down of Silk Road (a market for criminal activity), mismanagement at Mt. Gox, government intervention or high profile hacking. They wonder if an early association with greed, graft, drugs or p○rn○graphy is an inevitable step (or a necessary step?) toward wider market adoption.

That question is not only insightful—it is brilliant! On the surface, Bitcoin has no more role in facilitating crime than cash transactions. But the question is valid, because large amounts of cash are difficult to slip into and out of monetary systems, and it cannot easily be transmitted with impunity.

Vice and markets with prurient appeal often drive adoption of new technology. This connection is a widely recognized axiom by economists. In fact, it suggests a good reason as to why non-criminals should not be alarmed. Even though they represent the underbelly of a paradigm shift, Silk Road and other news making scoundrels or events are playing a role in the early diffusion of a fascinating technology. Law enforcement can address these things as they arise. But, they no more spell long-term doom than p○rn did for the VCR.

This same discussion participant opined that wild gyrations in the Bitcoin exchange rate (the relationship to national currencies) would retard adoption for quite some time.

Bitcoin Volatility: A Wild Duck opinion

The wild gyrations of Bitcoin are a byproduct of (any) rapidly growing and somewhat misunderstood technology. These will iron out. On this point, I am certain. Eventually, as a subset of Bitcoin users store the coins rather than convert them with each transaction, these gyrations will be perceived to be instability in the Dollar, Euro or Yuan and not with Bitcoin. That is, for now, vendors are setting a price in legacy currency (Dollars) and offering to Bitcoin buyers at the current exchange rate. Then, they are converting back out of Bitcoin. But a gradually growing body of vendors will hold their BTC either for future transactions, or because they trust and value it as a holding. This simple fact will gradually iron out the wild swings. As adoption grows; as supply and demand find a reasonable meeting point; and as individuals retain their holdings, the volatility will abate.

The Virtual Currency Collaborative

Incidentally, a newly formed collaborative was formed earlier this week by members of the LinkedIN group, Bitcoin P2P Digital Currency (same thread). It is already playing a role in the long term viability of Bitcoin. These entrepreneurs are defining mechanisms and policies that will ensure that Bitcoin is just as friendly to business and commerce as it seems to be for parties to anonymous or unreported transactions. The Virtual Currency Collaborative (working title—the developer’s site is still under wraps), is the working group that will specify secure, trusted protocols and mechanisms for legitimate businesses everywhere. These businesses often require user identification, escrow, recourse and the support of audits & forensics.

Mt. Gox: Comeuppance for a Bitcoin king

Posted on by
Reply

Feb 24 Update: Coinbase, Blockchain.info & other execs issue statement:

■  Refer to Mt. Gox ‘insolvency’.  ■  Web site vanishes.
■  Mysterious loss of more than 700,000 Bitcoins.

I have never been a fan of Mt. Gox, the big Bitcoin exchange based in Japan. From early in their history, I have complained that they lack the standards, oversight and methodology to hold their position as de facto linchpin in an emerging field.

Glitch —vs— Catastrophe

I used to run a large email service. We earned all the top Editors’ Choice awards and were featured in every tech publication.

Like any service provider we had occasional glitches that prevented a fraction of users from accessing mail in a timely fashion. Occasionally, a denial-of-service attack or an upstream peering dispute would degrade service to all users. But, there was one time that all users were locked out of our servers. It happened at the worst possible time — during a summer holiday. Imagine the gooey stuff hitting the fan as our clients started their holiday without email.

Even though we posted service updates to our web site, our phones were under siege from the very beginning. After all, email is the primary communication medium for many individuals.

We developed expertise in preserving good will. Most importantly, we informed users about the problem, updated them frequently, and learned from our mistakes. But, we sometimes deflected blame. When problems were related to an upstream provider or a situation ‘beyond our control’, we learned that with selective disclosure, we could avoid the full brunt of user frustration. It was a bit was disingenuous, because, in most cases, the problems could have been avoided with a more robust fail-over implementation.

Calamity Hits Mt. Gox

mtgoxBy now, anyone who dabbles in Bitcoin is aware that the exchange purported to be the biggest, baddest gun in the west is blocking all withdrawals. That’s right. You can put money in, but you can’t take it out. The excuse: “We have identified suspicious transactions.”

Of course, with millions of dollars of client assets in the balance, even an unregulated organization cannot rest on that explanation for long. And so, Mt. Gox has clarified their radical move, claiming that there is a bug in core code maintained by the Bitcoin Foundation. They refer to this bug as “transaction malleability”.

Mt. Gox implementation protocol: Serious risk to customers

Not only does Mt. Gox blame the Bitcoin Foundation for transaction malleability, they conclude that “Bitcoin is a very new technology in its early stages.” Yeah, sure! That’s another way of saying that some companies lack the resources to keep up with a reference design or to practice due diligence in testing proprietary implementations. Read between the lines, wild ducks: The problem is not with Bitcoin prime, it is with Mt. Gox’s convoluted attempt to create sidecar code in an effort to achieve scale and proprietary advantages.

Mt. Gox tossed the reference code and developed their own wallet process. Then, they failed to keep up with published changes to the reference standard—many related to security, distributed reporting and scaleability! If Mt. Gox thinks that they have an edge on these issues, they should reconsider their complaint about the early nature of the art. Instead, they ought to join established working groups and improve the process from within. In that way, they can avoid forking far from the tracks and throwing customers under the bus.

Coinbase_Logo

It’s no surprise that the Bitcoin foundation turned the table on Mt. Gox, blaming them for the problem. Likewise, here is the response from Coinbase, the San Francisco based exchange (also pasted below). As for me, I will bite my tongue and withhold further commentary. Suffice it to say that I agree with the Coinbase position and that

I have never felt that Mt. Gox was deserving of trust or of being the heavyweight in the room.

Was a spectacular failure inevitable?

Glitches are an inevitable result of new technologies—especially when the technology relates to a dramatic shift or emergence of a new mechanism, like cryptocurrency. But fiascos of this magnitude are typically avoided in a shakedown that occurs early on. In this vignette, I the ‘glitch’ is the uncanny survival of Mt.Gox as a credible entity through the first months of 2014.

Stacks of BitcoinWhat does it mean for Bitcoin?

In the days after the Mt. Gox fiasco, the Bitcoin exchange rate retreated 48% to $480. Clearly, many stakeholders were shaken and there a sufficient number of them have sparked a panic, heading for the exit door.

So what does this mean for Bitcoin? Is the fat lady rehearsing the closing aria? I have never considered Bitcoin be an equity play—Ultimately, it is a currency and not an investment. In fact, it is a near perfect exchange medium and adoption is growing like a weed. As such, those with a BTC in their wallet will almost certainly see an increase in value. That’s the inevitable fallout when you factor the intersection of increased adoption and fixed supply cap.

For individuals sitting patiently on the sidelines, waiting for a good moment to fund a their transaction kitty, this current event makes for a spectacular buying opportunity. There is every reason to believe that Bitcoin will be a respectable world currency, despite objections over its lack of intrinsic value. And with permanent market cap of 21 million units, the a value under $500/coin will one day seem to be an incredible bargain.

___________________

Coinbase Response to Mt. Gox problems…
Bitcoin’s Transaction Malleability Issue  (Feb 10, 2014)

Earlier today, Mt.Gox released a press release highlighting the “Transaction Malleability” issue with the Bitcoin protocol.  Gavin Andresen, Lead Developer of the Bitcoin protocol later released a statement confirming that this is not a problem with the Bitcoin protocol, but is a challenge for creators of bitcoin wallet software (like Coinbase).

The malleability issue would allow an attacker to change the identifier of a transaction (but not the sender or recipient of bitcoin, amounts, or other information).  If not accounted for carefully, this could lead some wallets to duplicate transactions.

After conducting a review of our wallet software, we could not find any instances of such an attack being used. We also looked into the technical details of the transaction malleability issue and just this morning added additional security measures to our software to further prevent such an attack. From our current analysis, there weren’t any users affected by this issue, but we’ll continue to monitor transactions to make sure.  If you have any questions about a transaction on your account you can contact support.

Bitcoin is a truly exciting space to be in. Every day, more and more consumers and merchants are experiencing the value of bitcoin – simple, instant transactions – exactly what payments should be in the age of the Internet. With nearly 1M consumer wallets and over 23,000 merchants on our platform, Coinbase will continue to stay vigilant and do everything we can to make Bitcoin as easy as possible for customers.

China creates a Bitcoin buy opportunity

Posted on by
Reply

When governments seek to inhibit, retard or ban a grassroots movement, it almost always has the opposite effect. Official acts of suppression tend to fuel publicity and growth by shining a light on the activity or venue that some wish to suppress.

The US government apparently knows this. Perhaps that is why a Justice Department official said on November 18 that Bitcoins can be a “legal means of exchange” at a U.S. Senate committee hearing.

  • Mythili Raman, acting assistant attorney general at the department’s criminal division, told the Committee on Homeland Security and Governmental Affairs “We all recognize that virtual currencies, in and of themselves, are not illegal”.
  • Federal Reserve Board Chairman, Ben Bernanke, told the Senate committee that the U.S. central bank has no plans to regulate the currency. He wrote to lawmakers: “Although the Federal Reserve generally monitors developments in virtual currencies and other payments system innovations, it does not necessarily have authority to directly supervise or regulate these innovations or the entities that provide them to the market”.

Of course, as with any monetary authority, the US government needs to preserve public faith in the dollar, and also avoid an exodus to digital currencies, even if used only for online transactions. But rather than attempting to ban individuals from investing in Bitcoin or using it as a currency, the US subtly discredits Bitcoin by placing fear and doubt in the minds of would be traders. For example, in this interview, former fed chairman, Alan Greenspan, explains with remarkable clarity why he believes it is foolish to accept Bitcoin as a currency.

Dr. Greenspan is smarter than me and I am certain that he believes what he says. But I respectfully disagree that trust comes only from the Aristotle doctrine of intrinsic value. Even without the backing of a trusted government or bank, investment value can arise from a combination of provable scarcity and widespread recognition.

Short term investment?  —  or
Long term exchange medium?

I prefer to study Bitcoin as an emerging global currency rather than as an investment vehicle. But even as an investment, its potential is inextricably linked to the likelihood that it will catch on as a currency—at least in some sectors or in some countries. So, let’s look at this possibility…

The long term viability of Bitcoin as a currency depends upon sustained trust by a large number of vendors and consumers. That is, buyers and sellers must feel that there will be broad or growing audience to accept the coins that they accrue, and that the value of their savings—or even of daily receipts—will not be eroded by inflation or a sudden lack of faith. (I am not too concerned with wild swings in exchange value during early adoption. These tend to be overlooked by “bleeding edge” adopters or at least the significant fraction of them that have a strong stomach).

Why is Bitcoin falling?

Bitcoin_pullbackThe short answer: it’s not falling for long. It is adjusting in response to politics, but it almost certainly will return to its historical trend.

The upward path of Bitcoin is already the stuff of legend. The exchange rate with the US dollar rose from nothing to $12 in the first 2 years of trading. This year, it peaked at $1240 on Thanksgiving Day in late November, but then pulled back as low as $650 over the next week. The fall was precipitated by a warning from the Chinese government to its citizens. Their announcement did not ban owning or trading Bitcoins, but it warned citizens that it was a very risky investment and also that it must not be used as currency in any transactions.

After pausing at around $700 for a day, it returned to a range of $850~1050 for most of December. But there was another sudden drop last night, on December 17. It pulled all the way into the high fours before settling between $550 and $600. (This posting was written on Dec 18).

But what happened last night? What caused the second nosedive in this graph?

China_effect_on_Bitcoin

Answer: China is at it again. It is using direct engagement rather than subtle persuasion in an attempt to block gradual adoption of a decentralized, uncontrollable phenomenon. Last night, China’s biggest Bitcoin exchange was barred from accepting new Yuan deposits. But it was not shut down. Citizens can continue to sell and trade Bitcoins that are already in their account and the exchange can still accept cash from outside the country.

Some would say that the downward pressure is a natural response to law and public policy. Wild Ducks augment this argument by pointing out that the fall is a temporary and technical effect. More to the point—we see it as a buying opportunity.

Of course, I acknowledge the short term risk and I continue to downplay the role of Bitcoin as an investment. But I can’t shake the notion that early adoption leads to appreciation over the course of a maturing commodity. I also can’t shake extreme excitement over a property of Bitcoin that places it head-and-shoulders above government and bank-backed currencies: The supply is capped. It simply cannot be printed, inflated, or used as a political tool. It also resists efforts of governments to attack personal wealth as the basis for mandatory redistribution, at least without full and wholehearted consent of the governed.

Given the choice of using it as currency later or owning it earlier, why not do both?

Further reading:

Ellery Davies is acting technology editor for AWildDuck. He dabbles in law, economics, and public policy and has been fascinated with Bitcoin for years.